Some justice for existing borrowers?

When interest rates go down, banks tend to increase the spread for older customers, and their EMIs stay same

If retail borrowers start a #metoo campaign, all lenders would have to plead guilty. And, the Supreme Court (SC), finally, seems to have stepped in to stem this rot. 

The SC responded to Moneylife Foundation’s petition which highlighted the unfair practice of banks to charge one set of customers a different interest rate vis a vis similarly placed earlier customers, and sought a response from the Reserve Bank of India (RBI) in the next six weeks. 
 

Lenders in India charge different rates to new and old customers. And various methods are used to do this. The most common practice is to increase the rates when there is a rising trend, but not reduce them when the cycle changes. It is done by manipulating the calculation of the benchmark rate. In some cases, they increase the spread over the benchmark rate. 

New borrowers, always, get the latest available rates since the competition is stiff. Once they become old, the same treatment is meted out to them. The trend has been observed by committees set by the apex bank. The latest study group (led by Janak Raj) had submitted its initial report in September 2017 and final one in February 2018. The recommendations include: 

• All floating rate loans to be linked to an external benchmark
• Reset of floating rates to be at least once every quarter on a fixed date
• Banks can charge whatever spread they want over the benchmark rate, the spread to remain constant over the entire loan tenure 
• Compulsory migration from all earlier loan to the new system within a defined time frame

It’s not clear why the RBI did not implement the recommendations, but it’s possible that the lenders bought time by giving the excuse of corporate non-performing assets.

If true, this would be the biggest institutional case of robbing Peter to pay Paul. Retail borrowers are being made to pay for the sins of the high-flying corporate borrowers. 

A few additional suggestions:

• Whatever regime is announced, it needs to apply to all lenders including , and not just banks 
• The interest rate reset should be done by increasing/decreasing equated monthly instalments and not by adjusting tenures to make sure that the consumers understand the impact of the floating rate regime
• The quarterly reset dates should be fixed across the industry (say April 1, July 1, October 1 and January 1) so that there is an ease of comparison 
• The compulsory migration to the new regime should be within six months of the new regime kicking in so that the impact of the new regulations is immediately felt

Let’s hope that the SC will finally force the regulator to make sure that retail borrowers are treated fairly. 

The writer is a Sebi-registered investment advisor